In Cyprus Transfer Pricing rules are regulated by the circular issued on 30 June 2017 by the Cyprus Tax Authorities (CTA) (the "Circular") revising the transfer pricing framework for companies carrying out intra-group financing activities in Cyprus. Therefore, all related companies' transactions in which Cyprus Tax Resident Companies are involved, are obliged to follow the arm's length principle as set out in the OECD Transfer Pricing Guidelines. The Circular is effective as from 1 July 2017.
The Circular applies to Cyprus tax resident entities and permanent establishments which are involved in back-to-back intra-group financing transactions. The Circular defines intra-group financing transactions as the granting of loans or cash advances to related companies (within the scope of Section 33 of the Cyprus Income Tax Law) that are (or should be) subject to interest and are financed by financial means, such as debentures, private loans, cash advances and bank loans.
Transfer Pricing Study
TPS (Transfer Pricing Study) is defined as the supporting document to be provided to the Cyprus Tax Authorities, evidencing that the transaction which took place, was based on the Arms' Length Principle. The Circular prescribes the minimum requirements that need to be included in a transfer pricing report. In addition, it provides that the transfer pricing report should be (i) prepared by a transfer pricing expert, and (ii) submitted to the CTA by a person who has a license to act as an auditor of a company according to the Cyprus Companies Law Cap. 113 and is required to carry out an assurance control confirming the quality of the transfer pricing report.
Arm's Length Principle
The Circular provides that the remuneration arising from back-to-back intra-group financing transactions should comply with the arm's length principle i.e. correspond to the price that would have been agreed by independent parties in comparable transactions, taking into account the economic nature of the transaction. In this respect, a comparability analysis must be carried out for the purpose of:
(a) Identifying the commercial and financial relationship between the related parties and determining the conditions and the economically significant circumstances of the transaction and the Circular specifies that in order to precisely describe the intra-group financing transaction, it is necessary to determine the characteristics, such as its terms and functions, the assets used and the risks assumed by the related parties. The following matters should be considered and taken into account as part of the analysis: (i) Contractual Terms, (ii) Functional Analysis and (iii) Risk Analysis.
The Circular provides that the ability to assume and manage risk constitutes the economically significant characteristics which must be identified in order to describe precisely the transaction.
An entity is considered to be able to assume risk if it has the financial capability to manage the risk and bear the financial consequences in the event that the risk materialises. The Circular, sets out the methodology to be used as part of the risk analysis, including using comparables to credit institutions and investment firms pursuant to EU Regulation, in order to determine the entity's equity levels and whether these are sufficient to enable it to assume the relevant risk.
An entity is considered to be able to manage the risk if it has, and actually exercises, the decision making power to enter into risk bearing transactions and if it has the ability to address such risks.
In this respect, the Circular provides that entities:
(1) Must have actual presence in Cyprus, which is determined by taking into account the following criteria: the number of Cyprus tax resident directors, the number of the board of directors' meetings held in Cyprus and whether the main management and commercial decisions of the board of directors are taken in Cyprus, the number of shareholders' meetings held in Cyprus, etc,.
(2) Must have qualified personnel to control the transactions performed. It is noted that the Circular allows for the outsourcing to third parties of any functions that do not have a significant impact on risk control, including daily activities of risk mitigation, provided that the entity maintains control and supervision of the risk and function outsourced.
(b) Comparing the conditions and economically significant circumstances of the transaction with comparable transactions between independent parties
Once the transaction has been precisely described, then the arm's length remuneration is determined by comparing the transaction with comparable transactions observed between independent parties in the open market.
(For group companies exercising a purely intermediary financing activity and meeting the substance requirements listed above, the transactions entered into by such group financing companies will be considered as compliant with the arm's length principle if such group companies obtain a minimum return on the assets financed after tax of at least 2%.
Reliance on the simplified measure needs to be disclosed (when applied) in the tax return of the company and could be subject to exchange of information.
A deviation with the above-described requirement of a 2% minimum return is acceptable when duly justified in a transfer pricing analysis.
Hence, it may be necessary, to request the auditors to prepare the TPS and access the possible tax consequences and applicability of the Transfer Pricing Rules to this particular case.
Are there any tax consequences?
Article 9 of the OECD provides that in the case where the terms of two related companies in their commercial or financial relations differ from those of independent parties, then any profits that should have been accrued, (provided that the same terms of independent parties applied), may be included in the profits of the company and taxed accordingly The corporate tax imposed on the income) arising from the ordinary course of business or closely related to such is at 12.5%, hence the profits accrued could potentially be subject to 12.5% corporate tax.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.